The four biggest mistakes in futures trading

T R

A D E

S E C R E T S

The Four
Biggest
Mistakes
in FUTURES

TRADING

J AY K A E P P E L
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D I R E C T O R O F R E S E A R C H , E SS E X T RA D I N G C O M PA N Y, LT D .


The Four Biggest Mistakes in Futures Trading 1

THE FOUR BIGGEST
MISTAKES IN
FUTURES TRADING

B Y J AY K A E P P E L

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Copyright © 2000 by Jay Kaeppel
Published by Marketplace Books.
All rights reserved.

Reproduction or translation of any part of this work
beyond that permitted by section 107 or 108 of the 1976
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This publication is designed to provide accurate and
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author nor the publisher is engaged in rendering legal,
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From a Declaration of Principles jointly adopted by
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The Four Biggest Mistakes in Futures Trading 3

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o Maggie, Jenny and Jimmy

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pecial thanks to David and Suzanne

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C o nThet eFournBiggest
t s Mistakes in Futures Trading
INTRODUCTION
The Bad News, The Worse News, The Good News and
The Better News
Why So Many Fail
What Sets Futures Trading Apart
Attacking From The Bottom Up Versus The Top Down
One Word of Warning
Topics To Be Covered

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MISTAKE #1: LACK OF A TRADING PLAN
What is Mistake #1
Why Do Traders Make Mistake #1
The Recipe For Trading Success
(That Nobody Wants To Hear)
How To Avoid Mistake #1
The Litmus Test
How Much Capital Will You Commit To Futures Trading
What Market or Markets Will You Trade
What Type of Trading Time Frame Is Best For You
What Type of Trading Method Will You Use
What Criteria Will You Use To Enter a Trade
What Criteria Will You Use To Exit A Trade With A Profit
What Criteria Will You Use To Exit A Trade With A Loss
A Word Of Advice: Adhere to the Four Cornerstones
Go With The Trend
Cut Your Losses
Let Your Profits Run / Don’t Let Big Winners Get Away
Summary

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MISTAKE #2 : USING TOO MUCH LEVERAGE
What is Mistake #2
Understanding Leverage
Why Do Traders Make Mistake #2
How To Avoid Mistake #2
The Role of Mechanical Trading Systems
Determining The Amount of Capital Required
Single Market Factor #1: Optimal f
Calculating Optimal f
Single Market Factor #2: Largest Overnight Gap
Single Market Factor #3: Maximum Drawdown

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6 The Four Biggest Mistakes in Futures Trading
One Caveat to Analyzing Trading System Results
Arriving at a Suggested Dollar Value Per Contract
Arriving at an “Aggressive” Suggested Account Size
Arriving at a “Conservative” Suggested Account Size
Arriving at an “Optimum” Suggested Account Size
for Your Portfolio
Digging a Little Deeper
Summary

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MISTAKE #3: FAILURE TO CONTROL RISK
What is Mistake #3

Why Do Traders Make Mistake #3
How To Avoid Mistake #3
Risk Control Method #1: Diversification
Among Different Markets
Risk Control Method #2: Diversification Among
Trading Time Frames and Methods
Risk Control Method #3: Proper Account Sizing
Risk Control Method #4: Margin-to-Equity Ratio
Risk Control Method #5: Stop-Loss Orders
Placing a Stop-Loss Order In the Market Place
Using Mental Stops
Not Using Stop-Loss Orders At All
The One Important Benefit of Stop-Loss Orders
Summary

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MISTAKE #4: LACK OF DISCIPLINE
What is Mistake #4
Why Do Traders Make Mistake #4
How To Avoid Mistake #4
Overcoming The IQ Obstacle

A Word of Advice: Don’t Think, React
Avoid Simple Traps
The Cure for “Woulda, Shoulda, Coulda”
System Development versus System “Tinkering”
Asking The Right Question
Summary

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CONCLUSION

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APPENDIX A: Mathematical Formula for Standard Deviation
Standard Deviations

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INTRODUCTION
The Bad News, The Worse News,
The Good News and The Better News
First the bad news: best estimates suggest that 90% of
individuals who trade commodity futures lose money doing
so. Now for the worse news: This estimate may be too low.
The sad fact is that somewhere along the way the majority
of traders make one or more critical mistakes in their
trading, which cause their losses to exceed their winnings.
The good news is that the mistakes that cause most losing
traders to fail are quite common and readily identified.
These mistakes will be detailed in this book. The better
news is that by being aware of the potential for making
these mistakes and by taking steps to avoid them, you can
make a great leap towards becoming a more consistently
profitable trader. The information contained in this book
will help you to become a more successful trader – not
necessarily by teaching you to be a “good” trader, but by
teaching you how not to be a “bad” trader.

Why So Many Fail

To generalize using the broadest stroke possible, the high
rate of failure among futures traders can be attributed
primarily to three factors:

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• The lure of easy money
• The lure of excitement
• An utter lack of preparedness to deal with the potential
downside
Unfortunately, it seems that many individuals are lured into
futures trading for a lot of the wrong reasons. To draw
an appropriate analogy regarding futures markets and
futures traders, consider the following scenario.
Suppose someone offered anyone who shows up the
opportunity to drive an Indy race car around the track
with the promise that the person with the fastest time will
receive a $10,000,000 prize. Will a lot of people show
up to take a shot? You bet. Will most of them be truly
prepared for what they are about to do? Not likely. Will
someone win the $10,000,000? Of course. Will 90% of
the drivers fail to make it to the finish line?
Welcome to the exciting world of commodities speculation!

What Sets Futures Trading Apart
The staggering rate of failure among futures traders raises
several extremely relevant questions:

1)What is it about futures trading that causes such a high
percentage of participants to fail?
2)Is there a way to avoid the pitfalls that claim so many
traders?
3)If the failure rate is so high, why does anybody bother
trading futures in the first place?

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What is it about futures trading that causes so many people
to fail? People who have been successful in every other
endeavor in life start trading futures and quickly watch the
equity in their trading accounts vanish. Why is this? The
answer is really very simple. It is because futures trading
is unlike any other endeavor in life. If this sounds like an
overstatement, rest assured it is not.
There are several factors that set futures trading apart from
other forms of investment. To begin with, unlike the stock
market, where rising prices can make any number of people
richer, futures trading is a “zero sum” game. This means
that for every dollar you make trading, somebody else is
losing a dollar. If it is true that 90% of traders lose money,
then we must conclude that a small minority of traders are
making all the money at the expense of the vast majority.
Secondly, the futures markets involve a great deal more
leverage than most other types of investments. To put it
into comparative terms, if the stock market were a race car,
then the futures markets would be a rocket ship. While a

car going 200 miles hour is certainly “fast,” its speed pales
in comparison to that of a rocket ship traveling 3,000 miles
an hour. Finally, futures trading offers speculators the
opportunity to generate spectacularly exciting rates of return,
far beyond those available from other forms of investment.
Maybe that is part of the problem.

Attacking From The Bottom Up
Versus The Top Down
Many outstanding books have been written that focus on
successful traders and how they have achieved their

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successes. There is much to be learned from these books.
The only real problem with books that focus on successful
traders is the reader can come away with a false sense of
security. People may assume that by emulating the greatest
traders around they can be just as successful. But is that
a realistic expectation? Just because you know how
someone else succeeded in a particular field of endeavor
does not necessarily mean that you can duplicate his or her
success. Just because you read a book about how Warren
Buffet selects stocks doesn’t mean that you are destined to
be as good at it as he is. Yet this is how a lot of people
approach investing. They read a book or look at an ad
that tells them “how easy it is” to make money and later

on they are that much more surprised when they find out
that it is not so easy after all. There is much to be gained
by learning from and attempting to emulate traders who
have enjoyed a great deal of success. The danger is in
assuming that you will enjoy the same type of success
without paying some dues along the way.
This book takes the opposite view. Instead of focusing on
the traits that allow 10% of futures traders to be successful,
this book focuses on the most common and costliest pitfalls
that claim the 90% of traders who lose money. Consider
this the “how not to” lesson. By avoiding the mistakes
detailed in this book you clear your path of the major
obstacles that doom the majority of futures traders to
failure.

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One Word of Warning
If you are presently trading futures unsuccessfully or have
done so in the past, you may be about to take a cold, hard
look in the mirror and you may not like what you see.
But as with anything else that might cause you to look in
the mirror, the most important question to answer is not
“do I like what I see?” The more important question to
answer is “if I don’t like what I see, am I willing to change
my ways?” Generating a positive response to this question,
as well as offering some guidance as to where to start, is
the primary purpose of this book.

Topics To Be Covered
I.

The Four Biggest Mistakes In Futures Trading
1. Lack of a Trading Plan
2. Using Too Much Leverage
3. Failure to Control Risk
4. Lack of Discipline

II.

Why Do Traders Make This Mistake

III. How To Avoid This Mistake
For each of the four biggest mistakes in futures trading we
will first discuss what the mistake is. We will then examine
and try to explain why it is so common for traders to make
this mistake and why doing so causes traders to lose money.
Finally, the last portion of each section will try to offer
some guidance as to how an alert trader can catch himself
before he makes these mistakes and how to avoid them
altogether in the future.

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MISTAKE #1
Lack of a
Trading Plan
What is Mistake #1
Fortunately, for the purposes of illustrating Mistake #1,
there is a perfect analogy. Consider the following scenario.
You hear others talk of a business with low barriers to entry
and in which some individuals are getting rich beyond
anyone’s wildest dreams. After some consideration you
decide to take the plunge and engage in that business
yourself. It is a fair assumption that you will begin to do
some planning before engaging in that business. In fact,
if you are at all prudent the chances are great that you will
do a lot of planning before diving in. Furthermore, during
the planning process you may learn things that you did not
know at the outset that could affect your business, and you
will build in contingency plans to account for these factors
as well.
If you are like most people, and if you truly desire to
succeed, you may find yourself becoming consumed by the
depth and breadth of your planning. You may take pride
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in your efforts, and the extent of your preparation may

help you to build confidence in yourself and your chances
for success. Finally, after much soul-searching and
countless hours of planning and preparation, you take the
plunge and attempt to succeed in your new business. There
is nothing surprising in any of this. It happens all the time
and is simply the way that people go about making their
fortune.
Except when it comes to futures trading.
In futures trading, a surprisingly high percentage of traders
enter the markets without the slightest idea as to how they
plan to succeed in the long run. Very few traders begin
trading only after they have carefully thought through and
planned their foray into the “exciting world of commodities
speculation.” Most are so anxious to get started that they
just don’t take the time to make the proper preparations.
This phenomenon alone goes a very long way towards
explaining the high rate of failure among futures traders.

Why Do Traders Make Mistake #1
The answer to the question “why do traders make this
mistake” could probably apply to all of the mistakes in this
book. The primary cause of Mistake #1 is simply the lure
of easy money. The underlying thought seems to be “why
bother wasting a lot of time planning; why not start getting
rich right away?” This is understandable. There is
probably not a soul on this earth who works for a living
who has never once dreamed of making some huge sum
of money quickly and easily and then living a life of spoiled
luxury from that day forward. And the fact of the matter

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is that futures trading offers just that possibility (which is
exactly what makes futures trading so alluring, yet so
dangerous).
Consider these success stories:
• In a trading contest in 1987, Larry Williams ran $10,000
up to $1.1 million dollars in less than a year.
• Michael Marcus started with a trading account of $30,000
and over a period of years garnered over $80 million in
profits.
• Richard Dennis became a legendary trader in the grain
pits in Chicago in the 1970’s. Starting with a reported
$400, Dennis ran it up to over $200 million dollars (his
father is reported to have made one of the greatest
understatements of all time when he said, “Richie did a
pretty good job of running up that $400 bucks”).
Let’s face it; these numbers are staggering. Who in their
right mind wouldn’t want to achieve the kind of success that
these individuals have? Unfortunately, most individuals tend
to focus not on the “achieving” part of the process, but
rather the “post-achievement” period. In other words, if
you asked the question “could you imagine having this
much success trading futures,” most people would not begin
mentally drawing up plans as to how they would trade
soybeans. Quite the opposite. Most people would start
drawing up a mental laundry list of all the things they could
do with the money. The “doing” part is not nearly as sexy

as the “done” part.
What is missed in this kind of thinking is the reality of the
situation. Like all top professionals in any business,
successful traders, including the aforementioned individuals,
are not lucky. They made mistakes, they paid for their
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mistakes, they learned from their mistakes, they learned
what was required in order to succeed, and they did those
things no matter how difficult they were.
• In 1973 Larry Williams published a book titled “How I
Made One Million Dollars Last Year Trading Commodities”
detailing his trading success that year. The next year he
lost the million dollars.
• Michael Marcus started with $30,000, borrowed another
$20,000 from his mother and then proceeded to lose 84%
of their combined capital (imagine trying explain that to
your Mom) before becoming a successful trader.
• In 1987 several commodity funds managed by Richard
Dennis lost 50% of their capital and were forced to stop
trading.
The moral of the store is even the most successful traders
suffer tremendously from time to time. You will too. The
real question is “how will you react?”
One of the greatest dangers in futures trading is the danger
of high expectations. By focusing optimistically on how
much money he or she is going to make, a trader can

easily overlook the more important task of planning out
how to deal with all of the bad things that he or she will
inevitably experience. If you are walking down the street
and you trip and fall that is one thing. But, if you are
standing on a mountaintop and you trip and fall that is
something entirely different. And if you aren’t even aware
that you are standing on a mountaintop and you trip and
fall, then the only words that apply are “look out below!”
Traders who focus too much attention on how much money
they might make run a very high risk of a frightening slide
down a steep slope.

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The Recipe For Trading Success
(That Nobody WantsTo Hear)
As with any other endeavor, successful futures trading
requires a great deal of hard work. There is hard work
involved in planning and there is hard work involved in
following the plan. In the case of futures trading “hard
work” more often takes the form of making and following
through on difficult decisions, rather than on any type of
actual physical chore. If you hope to be a successful trader
you must be prepared to pay the price. The first step
begins with developing a well thought out trading plan that
covers all of the key elements involved.

How To Avoid Mistake #1

The only way to avoid Mistake #1 is to devote as much
time, effort and energy as needed to develop a trading plan
that addresses all of the key elements of trading success,
all the while knowing full well that doing so does NOT
guarantee your success. This daunting task moves futures
trading back from the realm of fantasy squarely into the
realm of reality. Your plan will serve as your road map
to guide you through the twists and turns that the markets
will throw at you.
There are many factors to be considered before one delves
into futures trading and which need to be revisited and
possibly revised as your experience and expertise grow. Yet
for far too many individuals these issues are dealt with on
an “as needed” basis, usually when there is money on the
line, and usually when money is being lost. This is exactly
the wrong time to be making critical decisions because they
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are more often than not based on emotion rather than on
sound thinking. In developing a trading plan there are
many questions to be answered and many different possible
answers.

The Litmus Test
The first question to be answered is not “how should you
trade futures?” The first question to be answered is
“should you trade futures in the first place?” One of the

keys to success in futures trading is being able to risk some
amount of money which, if lost, will not adversely affect
your lifestyle. In order to assess your level of readiness
in this regard, you should take the following test which will
tell you if you are truly prepared emotionally and
financially to trade futures.
Step 1. Go to your bank on a windy day.
Step 2. Withdraw a minimum of $10,000 in cash.
Step 3. Walk outside and with both hands starting throwing
your money up into the air.
Step 4. After all of the money has blown away, go home
and sit down in your favorite chair and calmly say,
“Gosh that was foolish. I wish I hadn’t done that.”
Step 5. Get on with your life.
If you actually can pass this test then you truly are
prepared, both emotionally and financially, to trade futures.
If you cannot pass this test then at the very least you need
to go into it with your eyes wide open (you may also take
some comfort in knowing that most new traders cannot pass
this test at the time they start trading). Once you have

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decided to go ahead and trade futures there are a number
of issues that need to be addressed.

How Much Capital Will You Commit To Futures Trading
If anyone asks you “what is the easiest way to make a

million dollars trading futures,” the answer is “start with
two million.” All kidding aside this is unquestionably a true
statement. The more capital you can afford to lose without
adversely affecting your lifestyle, the greater the likelihood
that you will be successful. More initial capital affords you
greater flexibility and more cushion when the inevitable bad
periods occur. This is so simply because having more
capital that you can afford to lose reduces your emotional
attachment to the money.
Emotional attachment to money is deadly. Ask successful
traders about the money in their trading account and almost
always they will say “I don’t think of it as money.”
Actually, thinking of it as money is not the worst thing.
The worst situation is when a trader looks at the money
in his trading account not as money, but as all of the things
he could buy with that money. If you find yourself after
a winning trade saying “well now I can buy this or that,”
or after a losing trade saying “well now I can’t buy this
or I can’t buy that,” you are in grave danger.
After you make the decision to trade futures the next step
is to decide how much money you can realistically afford
to risk. If you are going to open and trade your own
account it is recommended that the absolute bare minimum
account you should open is $10,000. A common
suggestion to traders is that you should always try to limit
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your risk on a single trade to an absolute maximum of 5%
of your trading capital (and ideally a lot less). If you open
a $10,000 account this means that you can only risk $500
per trade. In most futures markets this would be
considered a fairly “tight stop.” So if your timing is not
exactly right you will likely get stopped out on a fairly
regular basis. This is another reason why “more is better”
when it comes to starting capital.
Whatever amount you decide to commit, you should place
the entire amount into your brokerage account. For
accounts greater than $10,000 you can buy T-Bills with a
portion of your capital in order to earn interest. If you
decide to commit $25,000 then you should place the entire
$25,000 into your brokerage account. You may also
decide that if you lose say 50% of your capital, you will
stop trading. This may lead some traders to say “well if
I’m only going to risk $12,500 I’ll just put that amount
into my account.” This is a mistake. In the worst case
scenario it is a very different situation to be trading a
$15,000 account that started out as a $25,000 account
than to be trading a $2,500 account that started out as a
$12,500 account. Once your account dips under a certain
level your flexibility is so limited that it is essentially like
piloting a plane in a death spiral. You are at the controls
but you are no longer in control. One of the truest maxims
in trading is “if you absolutely, positively cannot afford to
lose any more money, you absolutely, positively will lose
more money.” Don’t doubt this one for a second. Think
seriously about how much you can truly afford to commit
and then commit the entire amount.

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What Market or Markets Will You Trade
The next decision is whether to specialize in one market
or to diversify across different markets. This is a very
personal choice. At first glance it would seem easier to
focus all of your attention on a single market. However,
there are pitfalls to such an approach. First, it is extremely
difficult to always make money in any single market. So
if you trade only one market and you go into a bad period
of trading, you have no other avenues for offsetting your
losses as you might if you were to trade a diversified
portfolio of markets. Secondly, experience has shown that
the majority of traders who have successfully specialized in
one market are floor traders who actually “make a
market” in that commodity. A little explanation is required
in order to understand the benefit they enjoy.
If you want to place an order in a particular market, you
can call your broker and ask for the latest “bid” and “ask”
prices for that market. If you are trading September
Soybeans for instance, he may tell you “the bid is 510, the
ask is 510 ˘.” This seemingly tiny spread has significant
implications. What it means is that if you immediately place
a market order to buy September Soybeans you will buy
them at 510 ˘. If you immediately place a market order
to sell September Soybeans you will sell them at 510. The
person on the other side of this trade is the “market

maker,” who is the individual who sets a bid and ask level
(in reality it is not just one individual). In essence, for the
“privilege” of getting a fill you are giving up a ˘ point,
or $12.50 on one contract in this example. In other words,
if the bid and ask are 510 and 510 ˘ respectively, and
an order to buy comes into the market, the market maker
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stands ready to sell at 510 ˘. If an order to sell comes
in the market maker stands ready to buy at 510. The retail
trader pays the difference between the bid and the ask and
the market maker pockets the difference. In theory, the
difference between the bid and ask is a risk premium
intended to give market makers some inducement to
assume the risk of making markets.
The purpose of this discussion regarding bid and ask prices
is to illustrate why traders who successfully specialize in only
one market are usually market makers and not retail
traders. Simply stated, they have an “edge” by virtue of
being able to buy at the bid and sell at the ask. The retail
trader never buys at the bid nor sells at the ask. If you
plan to be a market maker or if you truly feel you have
some type of edge in a particular market, fine, just trade
that market. Otherwise, it is suggested that you trade a
portfolio of at least three markets.

What Type of Trading Time Frame Is Best For You

The phrase “trading time frame” refers to the length of
time that you generally plan to hold trades. Will you trade
short-term, long-term or somewhere in between? Also,
what is your definition of short-term, long-term, etc.? This
is a critical decision as each individual has a different
temperament for risk. It is essential to trade in a manner
that fits your own personality. If you have trouble holding
on to a trade for more than a few days it makes little sense
to use a long-term trading approach. The aforementioned
market maker (buying at the bid and selling at the ask) may
often hold a trade for as little as 10 seconds (buying 20
Soybean contracts at 510 and 10 seconds later selling 20

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contracts at 510 ˘ yields a $250 profit). There are offfloor traders who trade in and out using anywhere from
1-minute to 5-minute bar charts. They are often day
traders who are always flat by the end of the day. On the
other end of the spectrum, there are traders who might use
fundamental information or monthly bar charts to trade.
These traders focus their attention entirely on long term
trends. And in between there are trend-followers, countertrend traders, traders using Gann, Elliot Wave, volatility
breakouts, moving averages, etc., etc.
Day traders will tell you that day trading is the best way
to trade and will give you very good reasons why they
believe this is so. Trend-followers will tell you that trendfollowing is the only way to go, and so on and so forth.
The bottom line is simply this: No matter what anyone tells
you, there is no one best way to trade. You must identify

the approach that is best suited for you personally. If you
can’t follow the markets all day, then it is unrealistic to
expect to be a successful day trader. Let me give you a
real-life example.
A pediatrician decided to day trade the S&P 500. At first,
he would run back to his office between appointments and
check the quote screen and perhaps make a trade, before
rushing to his next appointment. As the losses began to
mount he would start saying “excuse me for a minute”
during appointments to go check the quotes. Eventually
he started running late to appointments or would leave
appointments and not come back for 5 to 10 minutes while
he tried to trade his way back to profitability. Would it
surprise you to learn that he lost money, stopped day

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TRADE SECRETS

trading the S&P and had to do a lot of apologizing to retain
a good portion of his clientele? Probably not. In
retrospect this was clearly a recipe for disaster. In this
case, the lure of easy money—the idea that he would “trade
in and out” a few times a day and pick up some extra
cash—was so enticing to this individual that he made the
mistake of not acknowledging to himself that his schedule
was simply not suitable for day trading.
The purpose of this example is not to denigrate day trading
(nor day-trading pediatricians). The real point is this: if

you took a very successful day trader and forced him to
trade only once a month using fundamental information he
would no longer be a successful trader. Likewise if you
took a successful long-term trend-follower and forced him
to trade 15 times a day he too would be like a fish out of
water and he would no longer be a successful trader.
When starting out, making a well thought out decision
regarding the trading time frame is critical. Also, if you
have traded for awhile with little or no success it may be
time to look at altering your trading approach to use a
shorter or longer time frame. The bottom line is that there
is no inherent advantage to trading more often or less
often. The question to be answered is simply to determine
which approach works best for you.
To get a feel for the differences in a possible trading time
frame, examine Figures 1-1, 1-2 and 1-3. Each figure
displays the price action of T-Bond futures over a three and
a half month period. The only difference is that each
depicts the trading action using a different trading system,
one long-term, one intermediate-term and one short-term.

Trắc1 8nghiệm kiến thức Forex tại : />

THE FOUR BIGGEST MISTAKES IN FUTURES TRADING

On the graphs, an up arrow indicates buying, a down arrow
indicates selling, and small diamonds indicate stop-loss
stops. Trading the same market, the long-term system
made 2 trades, the intermediate-term system made 9
trades and the short-term system made 24 trades.

Figure 1-1 – Long-Term Trading Method

Courtesy: Futures Pro by Essex Trading Co., Ltd.
Figure 1-2 – Intermediate-Term Trading Method

Courtesy: Futures Pro by Essex Trading Co., Ltd.

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